Don’t Blame Panama: The Real Threat Facing Yahoo

Taking a look at Yahoo’s first quarter number, one word comes to mind: heedless.

Not “heedless”, as in Yahoo executives who led the Street on until it believed that, thanks to its vaunted Panama search technology, revenue and profits would surge in the first quarter of 2007. Or even “heedless”, as in investors who had gotten a little ahead of themselves by betting that Panama would deliver sooner than promised.

No, Yahoo CEO Terry Semel was clear on that point a quarter ago: “The first time we see any benefit will be at the end of the second quarter,” he told the New York Times. “Every quarter thereafter we will start to get better.”

Despite that cold dose of reality, Yahoo bulls bid up the stock 19% since that cautionary interview. It could charitably be written off to long-term optimism. But today, people are slamming Yahoo for getting it wrong.

“Yahoo recently overhauled its online advertising system, giving some investors hope for a positive earnings surprise. So far, that hope hasn’t materialized,” the Wall Street Journal wrote Tuesday. Who knew?

Any selling Wednesday on Yahoo’s first quarter results may miss the point. Yahoo could be facing tough times in 2007, but not because Panama didn’t lift profits in the first quarter, but rather because of something that happened last week: Google is finally getting serious about banner ads.

The real threat for Yahoo is that it could well remain on the wrong side of the profit pendulum. Here’s what I mean by that.

Yahoo was a big player in search before Google came along. But it didn’t capitalize enough on that position. Instead, it focused on branded ads (a nice way of saying banner ads – something that regular Web users have learned to either ignore or block, but not enough for Yahoo or, now Google, to care.).

Want to know the dirty little secret of Yahoo’s stock? It’s this: In the two years before Google went public, its stock rallied 376% to $28.61 from $6.01. As of Tuesday, before Yahoo’s first quarter 2007 report, it had risen another 12% to $32.09.

That’s partly because, before Google IPO, investors had nowhere else to put their money than Yahoo. Then came Google, who knew better than Yahoo how to make ad money off search results: that is, no banner, only text ads that maybe, just maybe may be relevant to you.

In other words, the pendulum swung. Search/text ads grew like crazy even if banner ads grew at a more-than respectable pace. Yahoo realized it had to match Google in its intuitive search algorithms, so it began to hatch Panama. It wasn’t an easy proposition. There were critical delays.

Still, Yahoo remained clear about Panama’s timing, warning investors if it would release later than expected – which is more than Google did for the un-beta release of Google News or that Microsoft did for … well, pretty much anything Microsoft ever did. No one ever called Panama vaporware.

And they shouldn’t today. Because the real risk for Yahoo is that Panama is finally catching up to Google right as Google is catching up to Yahoo in its core market of branded – er, banner – advertising.

This could go either way: If you’re a true believer in Google’s instincts, banner ads (along with video ads) will catch up with its text and search ads. But if Yahoo has been right all along, Google is essentially leveling the playing field to Yahoo’s advantage.

The antitrust concerns about the DoubleClick buyout are off mark, but I do wonder if they may help tip the balance from Google toward Yahoo.

Take Semel Tuesday on Yahoo as a alternative to Google: “We have heard concerns from various advertisers, ad agencies and others,” he told Reuters. “My guess is there’ll be some who are fine and there’ll be many who, perhaps, aren’t fine. That’s up to them.”

So it is. Everyone else, place your bets now.

Who will be the real heedless: Investors in Yahoo, which loses ads to Google because of its superior ad-personalization algorithms? Or investors in Google, because Yahoo’s Panama eats into its search pie, while the DoubleClick deal prompts advertisers to defect to the prime alternative, Yahoo?

Thank you, Internet gods. Just maybe, it is once again a two-horse race.

Kevin Kelleher is a writer living in Berkeley, Calif. He has a regular stock column at TheStreet.com and is a contributor to Wired, Business 2.0 and Popular Science. He has previously worked at Bloomberg News, Wired News and The Industry Standard magazine.

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